Arrange the following steps for calculating Goodwill under Capitalisation of Average Profits Method in correct sequence-
(A). Ascertain the actual firm's capital (net assets) by deducting outside liabilities from the total assets.
(B). Compute the value of goodwill by deducting net assets from the capitalised value of average profits.
(C). Ascertain the average profits based on the past few years' performance.
(D). Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits.
Choose the correct answer from the options given below:
Arrange the following steps for calculating Goodwill under Capitalisation of Average Profits Method in correct sequence-
(A). Ascertain the actual firm's capital (net assets) by deducting outside liabilities from the total assets.
(B). Compute the value of goodwill by deducting net assets from the capitalised value of average profits.
(C). Ascertain the average profits based on the past few years' performance.
(D). Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits.
Choose the correct answer from the options given below:
Solution
The Capitalisation of Average Profits Method follows a systematic approach to calculate goodwill:
Step 1: Calculate the average profits from past years' data. This forms the base for further calculations.
Step 2: Capitalise these average profits using the formula:
Capitalised Value of Average Profits =
Step 3: Determine the firm's actual capital (net assets) by using:
Net Assets = Total Assets - Outside Liabilities
Step 4: Calculate goodwill by comparing the capitalised value with actual net assets:
Goodwill = Capitalised Value of Average Profits - Net Assets
The logic is straightforward: we first establish what the firm earns on average (C), then determine what capital would be needed to generate such profits at a normal rate (D), compare this with the actual capital employed (A), and the difference represents goodwill (B).
The excess of capitalised value over actual capital indicates the firm's earning capacity is higher than normal, which is attributed to goodwill.
Correct sequence: (C), (D), (A), (B)
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